Crash And Rally: What We Can Learn From Owens & Minor

Summary

• Owens & Minor was certainly an interesting stock the last few years and we can learn a lot from it.
• An almost 95% decline in value was followed by a 1,000% rally.
• With improving numbers for fiscal 2020 and solid guidance for fiscal 2021, Owens & Minor still seems not overvalued.

The current stock market is producing a lot of crazy stories of success and phenomenal returns and when an index – the Nasdaq-100 (QQQ) – already increased more than 100% since the March 2020 low, we should not be surprised about several stocks also increasing in the high triple-digits (sometimes even quadruple digits).

Owens & Minor (NYSE:OMI) as well as Bed Bath & Beyond (BBBY) are stocks that increased more than 1,000% since the previous lows. And especially GameStop (GME) became extremely famous and dominated the financial press for several days in January as the stock increased about 11,000% between April 2020 and the peak in January 2021.

(Source: Owens & Minor Investor Presentation)

In the following article, I will take a closer look at Owens & Minor and the rollercoaster ride the stock took in the last few years. The article will be split in three parts covering three phases of the stock’s history. The first phase are the years before 2016, when the stock reached its peak, the second phase are the years between 2016 and 2019 in which the stock almost declined to zero and the third phase includes the year 2020 when the stock began to recover again and actually enter an impressive rally. And every now and then we will also mention GameStop and Bed Bath & Beyond as these stocks had a similar performance as Owen & Minor.

Phase I

In the first phase, we look at the performance of the company and the stock until April 2016, when the stock peaked at around $40. In the years between 2010 and 2016, the stock more or less fluctuated between $30 and $40 and this is not surprising as the company could not really grow in these years. Revenue still increased during these years, but due to declining margins, earnings per share were stable at best and in some years between 2008 and 2015 earnings per share even declined.

(Source: Author’s work - originally published here)

But despite a mediocre performance and a bottom line that could not improve, we could still be pretty confident about the business. Owens & Minor could still increase its gross margin from 9.9% in 2010 to 12.4% in 2015, which has to be seen as positive sign. Operating margin could also be described as stable in the years between 2010 and 2015 and as a result, operating income stagnated more or less – in 2010 it was $196 million, in 2015 operating income was $229 million.

In my articles back then I also assumed, that Owens & Minor had an economic moat around its business. But I also showed, that Owens & Minor had reported weaker return ratios than its competitors McKesson (MCK), Cardinal Health (CAH) and AmerisourceBergen (ABC).

(Source: Author’s work - originally published here)

When looking at return on equity, Owens & Minor could only report an average RoE of 11.83% for the years between 2007 and 2016, while the competitors reported a RoE between 16.03% and 24.74%.

(Source: Author’s work - originally published here)

And when looking at return on invested capital, the picture is quite similar: Owens & Minor could report an average RoIC of 9.04% while competitors had an RoIC between 10.33% and 14.10%.

We could also make the case, the Owens & Minor might have been a bit overvalued in April 2016, when the stock peaked as the stock was trading around 36 times TTM P/E ratio and it was also trading for a price-free cash flow ratio above 30. When using a discount cash flow analysis, we have to assume that Owens & Minor had to increase free cash flow about 5% annually to be fairly valued. This might have been a bit too optimistic considering the performance of the prior years, but not completely unrealistic.

Summing up, Owens & Minor seemed like a solid business at the time and maybe was just a bit overvalued.

Phase II

In the second phase, the stock declined from April 2016 until summer 2019 and in these three years the stock lost 95% of its value. In this phase, Owens & Minor made two major acquisitions – in May 2017 the company acquired Byram Healthcare and in November 2017 it acquired Halyard S&IP Business.

(Source: Owens & Minor Investor Presentation)

And while it seemed reasonable to assume the two acquisitions will lead to growing revenue – Byram Healthcare should have added about $470 million in annual revenue and Halyard should have added about $1 billion in revenue – quite the opposite happened. After TTM revenue peaked in summer 2016 it declined despite the acquisitions. During 2018, Owens & Minor could increase its revenue again after it declined before, but in 2019 and especially in 2020 revenue declined pretty steep. In 2018, 2019 and 2020, the company had to report nine quarters with negative GAAP EPS in a row.

(Source: Seeking Alpha Charting)

The acquisitions didn’t lead to higher revenue or higher earnings for Owens & Minor, but they led to much higher debt levels. In April 2018, Moody’s downgraded Owens & Minor to B1 and therefore to a “highly speculative” ratings category. S&P Global downgraded OMI to BB in May 2018.

In the second quarter of 2018, the company had $1,669 million in long-term debt. Compared to total equity of $802 million, we get a debt/equity-ratio of 2.08. This is a rather high D/E ratio, but seems still manageable. But the D/E ratio is only one facet of the picture. At that point we could assume, that Owens & Minor could generate about $200 million in operating income annually. It would therefore take more than 8 years to repay the outstanding debt, which is extremely long. And it gets worse, when we also consider, that Owens & Minor had to pay about $100 million annually in interest (about half of the company’s operating income would be used for interest payments leaving only about $100 million to repay the debt).

(Source: Owens & Minor Earnings Release)

And in the years 2016 till 2019, the difficult task investors were facing was to decide at which point Owens & Minor was a good investment. Until the fourth quarter of 2018, the dividend was certainly a reason for investors to buy the stock with a dividend yield of 7%. In August 2018, I also published my second article about Owens & Minor and at this point, the stock was trading for $16.29 and I considered the stock at least fairly valued (rather undervalued). I pointed also out, that the financial health of Owens & Minor was problematic, but I did not see the dividend cut coming. In October 2018, the company announced the first dividend cut and reduced the dividend more than 70% and only one quarter later Owens & Minor announced the second dividend cut and the dividend was basically zero ($0.0025 per quarter, one cent per year). And while the dividend was no reason any more to buy the stock, it was getting cheaper and cheaper and therefore a better and better value. But the difficult question to answer at this point was: Are we catching a falling knife or are we actually buying a valuable company.

Phase III

And for several months it seemed like Owens & Minor was a falling knife. The stock continued to decline and lost more than 90% of its value and hit its low in 2019 at $2.47. And at such a price level we can assume for most companies, that they are priced for bankruptcy.

But the stock could turn around and the stock gained more than 1,000% and is now trading at around $32 and therefore almost twice as high as when I published the two articles in 2018. Additionally, analysts were getting more optimistic about the stock again. At the lowest points, analysts estimated an EPS of $0.50 for OMI for the full year of 2020. But right now, estimates for fiscal 2021 are as high as $3.00 again.

(Source: Seeking Alpha Earnings Revisions)

Lessons To Learn

Owens & Minor taught me several lessons once again and the first lesson would be very simple: Believe in your own analysis. In retrospect it is always easy to say one was right, but that doesn’t make you any money. And I was also right with my two articles published in 2018 as Owens & Minor was trading at $16 at the time and the stock would have returned almost 100%. And I didn’t see the dividend cut coming, but I certainly saw the risks about the company’s balance sheet. I don’t say it is always easy to decide if a company is headed for bankruptcy or not, but when we can be pretty sure, that a company is not heading for bankruptcy a valuation like Owens & Minor saw in 2019 is absurd. And the fact, that Owens & Minor could report a positive free cash flow in every single year was also a strong sign, that the company was not headed for total disaster. In 2017, Owen & Minor could only report a free cash flow of $6 million, but it could generate positive free cash flow. I should not have been spooked by market participants driving the stock down into the single digits or I actually should have been grateful for the bargain – but that is always easy to say looking back.

I should not have been spooked by the market, but as Owens & Minor continued to decline, I actually lost interest in the stock (and was glad I did not invest). But it is actually absurd to lose interest in a stock, that is getting cheaper and cheaper and that has been identified before as solid investment. And identifying such extreme bargains can be extremely profitable (Owens & Minor increased more than 1,000% since the lows) as the stock market can be quite extreme in its exaggerations – to the upside as well as to the downside. The stock price was certainly justified to some degree, but an almost 95% decline was extreme for a company that did not go bankrupt. And identifying such companies can be extremely profitable.

And a third lesson from Owens & Minor would be the following: It is often quite difficult to distinguish between fundamental driven stock price movements (up as well as down) and euphoria/greed or panic. We have to be cautious as there are stocks out there, which rally for no good reason. Owens & Minor as well as Bed Bath & Beyond are two stocks, that rallied in the past twelve months and increased more than 1,000% since the bottom (BBBY is currently trading only 700% higher). But we also saw stocks, that rallied for no good reason – GameStop peaking at almost $500 was insane and certainly not driven by fundamentals. BBBY and OMI are both stocks that rallied due to the combination of improved business metrics on the one side and the rally starting at a point, where the stock price was extremely depressed on the other side. But euphoria certainly contributed to the stock price movement of BBBY and OMI and it sometimes seems difficult to distinguish between the different drivers of stock price movements.

What To Do Now?

One question remains at this point: What to do now about Owens & Minor? Is it still a good stock to buy? When looking at the fiscal 2020 results, we see several positive signs. When we ignore the declining revenue (8% YoY decline), we see an improved income statement. Owens & Minor could actually report GAAP earnings per share of $1.39 (compared to negative earnings in 2019) and adjusted EPS was even $2.26. And not only the bottom line improved again – Owens & Minor could also report a free cash flow of $280 million, which is the highest annual free cash flow during the last decade (and probably also the highest free cash flow in OMI’s history). Additionally, Owens & Minor improved its margins – gross margin (15.1%) and operating margin (2.9%) were both actually the highest reported numbers during the last decade.

(Source: Owens & Minor Q4/20 Earnings Release)

And not only fiscal 2020 was an improvement, Owens & Minor sees further improvements in fiscal 2021 and is expecting revenue to be between $9.2 billion and $9.7 billion, which is reflecting a growth rate between 8.5% and 14.5%. And adjusted earnings per share are even expected to be in a range of $3.00 to $3.50 per share.

(Source: Owens & Minor Investor Presentation)

When taking the adjusted earnings per share for fiscal 2021, OMI would be trading at a forward P/E of around 10 and can be called rather cheap and undervalued.

And we also see an improved balance sheet. On December 31, 2020, Owens & Minor had still $986 million in debt on its balance sheet, but with an improved total equity of $712 million, the debt-equity ratio is only 1.38. Right now, the company also has $83 million in cash and cash equivalents on its balance sheet, which could be used to repay the outstanding debt. When subtracting this amount from the total debt and comparing the number to the operating income of fiscal 2020, it would take 3.7 times the annual operating income. These numbers are still not great, but we should not be scared of Owens & Minor going bankrupt. We should also mention $394 million in goodwill on the balance sheet and while goodwill is never good, the amount seems acceptable compared to $3,336 million in total assets.

Conclusion

Owens & Minor is certainly an interesting stock as we can learn a lot about fear and greed and extreme market sentiments. And even after a 1,000% rally, the stock still seems not overvalued, but it is no longer the bargain it once was.

Analyst’s Disclosure: I am/we are long BBBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.